(This essay was published in Hong Kong Economic Journal on 25 July 2018.) 


The Chief Executive has made homeownership, particularly subsidized public homeownership, the centerpiece of her government’s public housing policy. This is very wise. It was first announced in her campaign platform and later in her first policy address. She has carried it forward by proposing a Starter Homes Scheme, regularizing the Green Form Subsidized Home Ownership Pilot Scheme (GSH), and increasing the discount on Homeownership Scheme (HOS) sale flats from the present 30 per cent to 48 per cent off the market prices of private housing flats.


There was no mention of reviving the Tenant Purchase Scheme (TPS) to sell public rental housing flats, despite calls from some quarters. Still, many pundits are surmising that her broad thrust towards expanding subsidized homeownership and making it more affordable represents a significant shift towards Singapore’s Housing Development Board (HDB) model.


The Singapore model and Hong Kong’s existing schemes are in fact quite different in both form and substance. The defining difference between them is not the level of subsidy, the size of the flats, or the eligibility criteria for admission, but the property rights structure under which people own public flats in these two cities.


This difference has two critical implications. First, it means there have been very different consequences for subsequent prosperity and inclusiveness in the two places.


Second, it highlights the shortfalls of Hong Kong’s housing policy. Singapore has had only one scheme from the very start, but in Hong Kong there have been many separate schemes over the years, some long lasting and others of shorter duration. The multitude of schemes reflects an underlying incompleteness of our housing policy to cater to the diverse and evolving demands of the population.


Mrs. Carrie Lam may either drew closer to Singapore’s public housing model or continue with Hong Kong’s existing schemes. Where Hong Kong’s housing policy should be heading towards is a question that deserves very careful deliberation. It is a complex subject and a great deal is at stake.


Property Rights Structure in Hong Kong


In Hong Kong, the buyers of HOS, TPS and GSH flats are in an important sense not full or 100 per cent owners of their flats. At the time of purchase, the eligible buyer receives a 30 per cent discount. The discount is based on the market valuation of a privately-owned flat.


If the owner sells the subsidized flat in the future on the open market, then she is required to pay back the unpaid 30 per cent discounted premium that she previously received. The value of this discount is, however, evaluated at the time of sale and not at the time of original purchase. So if the flat has appreciated in value, then the unpaid premium will increase.


From an economic perspective, the owner of the subsidized flat can enjoy 100 per cent of use value, but 70 per cent of its value as a transferrable asset. If the government can collect 30 per cent of the transferrable value of the property, and at the appreciated value, then it must be treated as a shareholder in the asset value of the flat. The owner of a subsidized sale flat does not possess an unfettered right to transfer the property without first surrendering to government 30 per cent of the value of the asset.


But the government is not a co-owner of the property in the legal sense. Its 30 per cent claim to the property value is established before factoring in any outstanding mortgage loans the owner might have incurred. In what sense has the property been sold at a discount in the first place? The discount applies to user rights, but not to transfer rights. What the government had subsidized is the user value, but not the transfer value.


Since both user and transfer values are embedded in the same physical asset, this type of arrangement is an inefficient use of public housing resources. The owner receives a very strong incentive to stay in the same property because she then gets 100 per cent of the use value. She is, however, discouraged from selling the flat when it is in the family’s interest to do so because she can only collect 70 per cent of the transfer value of the flat.


To illustrate the dilemma, imagine a flat’s use value to the owner declines by 15 per cent for a variety of reasons, say the family may wish to move to another area to live closer to work, schools for children, and grandparents’ home. But to do so the owner must sell the flat. The family may be forced to stay in the same location and accept the lower use value that has declined by 15 per cent, in order to avoid losing 30 per cent by selling the flat.


You may wonder why the owner would not lease out the flat without selling it to avoid the losses. Well, this is not permitted because the owner only has full user rights, but does not possess any leasing rights until they pay up the 30 per cent transfer value.


In 2010, the government seemed to recognize how ossified these restrictions were and, in a bid to revitalize the HOS secondary market, encouraged the Hong Kong Mortgage Corporation to provide second mortgage loans to help owners of subsidized flats pay off the 30 per cent transfer value so that they could lease out their flats. But the unpaid 30 per cent transfer value had appreciated significantly compared to the original purchase price and become far too expensive for most owners. It was a case of too little, too late. A bolder vision is thus needed.


The current situation means that subsidized sale flat owners are encouraged to stay in their flats far longer than they should. This reduces the geographic mobility of the population and imposes many other costs on society and the economy. To my knowledge, at least five economists in Hong Kong have separately estimated the enormous economic cost of public rental housing in distorting consumption and labor market behavior due to reduced geographic mobility. I believe there are analogous losses from imposing transfer restrictions on public sale flats. The magnitude of such losses is easily 1-2 per cent of GDP each year.


The Economics of the Share Tenancy


The sharing of output between the farmer and landowner is widespread in pre-industrial agrarian societies and is known as sharecropping or share tenancy. Share tenancy is an arrangement whereby a landowner engages a landless tenant to farm his land under a future output-sharing arrangement, for example, at a 50-50 sharing ratio.


British economist Alfred Marshall (1842-1924), founder of neoclassical economics, famously showed that the share tenancy was a hugely inefficient economic arrangement. His point was very simple. For a given quantity and quality of land, under a share tenancy arrangement the amount of output depends only on the effort of the tenant farmer. If any additional output resulting from greater effort on the part of the farmer has to be shared with the landowner, then his incentive to exert himself would be reduced because he cannot get the full reward of his additional effort.


Marshall reasoned that it would be more efficient for landowners to either offer a wage contract to hire farmers or a rental contract to lease out land to farmers. Competition among landlords and farmers would set wages equal to the marginal product of labor or rents equal to the marginal product of land. Contractual arrangements either in the form of wage-labor or land-rent would increase agricultural production efficiency and result in more output than the share tenancy arrangement. In practice, tenant farmers are typically too poor to pay rent so rental contracts are unlikely in pre-industrial agrarian societies.


How is Marshall’s argument relevant to Hong Kong’s subsidized sales flat scheme? And why does it matter?


Some might think that the buying and selling of flats is an asset transaction and does not involve production, so Marshall’s argument might not be relevant. The value of a flat rises or falls over time depending on aggregate demand and supply factors that are independent of the direct effort of the owner. But this is not so.


The housing services generated by a flat consist of the owner consumption service and the leasing out service. The latter is, however, not permitted for a subsidized sale flat. But as an owner, I can invest in renovation and maintenance to increase the level of housing consumption services. This element is equivalent to output produced on a farm.


The owner of a Hong Kong subsidized sale flat has less incentive to invest in renovation and maintenance because when he sells the property in future, he has to share the value enhancement with the government. Indeed, because of the lack of upkeep, if the flat were rented in future (which of course is not possible under present restrictions), it would fetch a lower rent. The result is underinvestment in housing services in subsidized sale flats unless the owner expects to remain there for a very long period of time.


This share tenancy arrangement explains why Housing Authority officials have found it so difficult to manage TPS owners. These owners are unwilling to share the cost of Housing Authority-initiated renovation and maintenance work because any enhancement in transfer value has to be shared with the government, even though it enhances the use value. I think the TPS owner cannot be blamed – they have insufficient incentive under a share tenancy arrangement to share the transfer value with the government.


Now if the owner did not have to share the transfer value with government, their behavior might be different. The behavior of the TPS owners proves Alfred Marshall’s point. Interestingly, Singapore’s HDB flats avoid this problem entirely.


Property Rights Structure in Singapore


The HDB flats are sold at a discount to permanent residents, and the discount is adjusted for affordability as economic conditions change. Some flats are available for rent, but most are for sale. Eligible residents can choose to rent or purchase. There is only one chance in a lifetime for a married couple to purchase at the discount rate.


After a period of restriction during which the flat cannot be sold (same as in Hong Kong), the owner can sell the flat on the open market at a market price to any permanent resident who does not own a flat. Leasing out the flat is also permitted. Any appreciation in value accrues entirely to the owner. In Singapore, the owner of an HDB flat purchases, at a discount, the full or 100 per cent of the user right, leasing right and transfer right to the flat.


The Singapore HDB scheme is therefore not a share tenancy arrangement. It does not generate the inefficiency consequences that the Hong Kong schemes do. HDB flats are well utilized among the population of permanent residents either for own occupation, rent or sale. Geographic mobility is not severely restricted as in Hong Kong where transfer values have to be shared with the government.


There is one right that the Singapore government has retained. HDB owners cannot redevelop their estates into private estates. When the structure becomes very old, they can only allow government to redevelop them into new HDB flats. In this way, these estates will never become foreign-owned.


What is the value of the absence of redevelopment rights in HDB flats? HDB flats sell on the open market at prices that are roughly 30 per cent lower than equivalent private flats. The discount reflects in part the value of redevelopment rights. It also reflects some underinvestment in renovation and maintenance when there is a limitation on redevelopment rights.


By contrast, the Hong Kong TPS, HOS and GHS flats do not have such legal limitations. Indeed, the very fact that the discount on subsidized sale flats is benchmarked against private market prices reflects the underlying property rights structure that means they could, in principle, be redeveloped into private estates.


What Should Hong Kong Do?


In summary, the Hong Kong approach restricts transfer and leasing rights, while Singapore’s approach limits redevelopment rights. Neither in my view is perfect. But while Singapore could conceivably justify its limitation on nation building grounds, does Hong Kong have a justification for its restrictions?


Amazingly, Hong Kong’s restrictions were introduced only after Phase IIIA of the HOS flats in 1982. The HOS units sold during Phase I-IIIA were offered with a 30 per cent discount and the requirement to share transfer values with government did not exist. It was, in essence, almost identical to the Singapore model and even better. It had no restrictions on redevelopment rights and subsidized sale flats could be treated similarly to private flats once the time restriction of sales was ended. Hong Kong would have had a single housing market to allocate the bulk of the housing stock.


But in 1982, new restrictions on the sharing transfer values and leasing services were suddenly imposed on the HOS flats. What happened? In 1981-82 the Volcker Fed increased interest rates in a bid to kill inflation. In Hong Kong, nominal property prices rose by 22.6 per cent in 1981 and fell by -13.5 per cent in 1982. Consumer prices rose by 26.5 percent in 1981 and 11.0 per cent in 1982. Inflation-adjusted property prices fell by -3.9 per cent in 1981 and -24.5 per cent in 1982. Both nominal and inflation-adjusted property prices continued to fall until 1984.


One can only speculate as to why the Housing Authority decided to impose a restriction on sharing transfer values at the start of one of the most severe deflations in the property market. . The “green-eyed” monster was out and government was apparently worried about selling the flats at deflated prices and at a discount. What a terrible mistake and what a huge price the Hong Kong public has had to pay ever since. This is not the Singapore model but our own mutant public housing regime.


Property prices have since soared and housing is no longer affordable for most. The government has finally relented to increase the market discount from 30 per cent to 48 per cent. But if this is only a discount on user rights and not transfer rights. In effect itmeans the sharing of the transfer value rises to 48 per cent, it will dampeneven more incentive to become geographically mobile. We will have entrenched Hong Kong’s mutant system much deeper. What a horrible destruction of value.


In 1982, when we embarked on a path to destroy land value, that value was still cheap. So why, today, are we going further and faster down this path when land values have become so expensive?


If the Hong Kong government were to reform its public housing sales flat scheme someday to follow Singapore’s model, we would create a better regime. Instead of adopting the share tenancy arrangement, the government should adopt an equivalent wage or rental arrangement. Actually, it is surprisingly easy to reform.


If a genuine 30 percent discount were offeredincluding transfer rights, as was the case in the Phase I-IIIA HOS flats, then the remaining unpaid value would only be 18 per cent since the sales price is set at a discount of 48 per cent off the market value. This 18 per cent could take the form of a deferred loan from government to be repaid when the property is transferred. This deferred loan would have a fixed value and could even accrue interest.


A deferred loan arrangement would not be a sharing of the future transfer value. It would avoid all the disincentive effects and inefficiencies and even inequities of the present mutant public housing scheme. I hope that this would be able to take Hong Kong towards the Singapore model, and a better Version 2.0 model with redevelopment rights.


In 1993, at a forum organized by the Tax Institute on retirement pensions, I advocated privatizing Hong Kong’s public housing as an alternative to introducing social pensions. Mr. David Webb accused me of bringing the Singapore HDB model to Hong Kong. At that time he did not like my proposal, but he was spot on. Although I had always described my proposal as privatizing public housing, he recognized it was actually the Singaporean model.


I hope we do not confuse what we are trying to do in Hong Kong today as proceeding on the path to Singapore. We are moving further away. The wrong path could cost us at a minimum 1-2 per cent of GDP and further worsen inclusiveness in society. How property rights are defined over public sales flats will have profound effects on the economy and society, and ultimately on politics.


When land values are so unaffordable in Hong Kong, our government must not shirk from the duty of providing a genuine discount on subsidized public sale flats. And end this nonsensical pseudo discount on user rights but not leasing and transfer rights. The “green-eyed” monsters in town should be roundly rebuked – populist envy should have no place in a civilized community.

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